KeyCorp (KEY) — Q3 2015 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2015; unaudited consolidated results. KeyCorp operates Key Community Bank and Key Corporate Bank. Comparisons below are primarily against Q3 2014, with balance-sheet comparisons also to December 31, 2014. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Financial performance and condition
| Metric | Q3 / September 30, 2015 | Comparable period |
|---|---|---|
| Taxable-equivalent revenue | $1.068 billion | $998 million, Q3 2014 |
| Net interest income, GAAP | $591 million; net interest margin 2.87% | $575 million; margin 2.96%, Q3 2014 |
| Noninterest income | $470 million | $417 million, Q3 2014 |
| Noninterest expense | $724 million | $706 million, Q3 2014 |
| Net income attributable to Key common shareholders | $213 million; diluted EPS $0.25 | $180 million; diluted EPS $0.21, Q3 2014 |
| Continuing-operations income attributable to common shareholders | $216 million; diluted EPS $0.26 | $197 million; diluted EPS $0.23, Q3 2014 |
| Loans / deposits | $60.1 billion / $71.1 billion | $57.4 billion / $72.0 billion, December 31, 2014 |
| Long-term debt / total equity | $10.3 billion / $10.7 billion | $7.9 billion / $10.5 billion, December 31, 2014 |
For the first nine months of 2015, GAAP net interest income was $1.746 billion (up from $1.711 billion), noninterest income was $1.395 billion (up from $1.307 billion), and noninterest expense was $2.104 billion (up from $2.057 billion). Continuing-operations income attributable to Key common shareholders was $668 million, versus $671 million in the prior-year period; total net income attributable to common shareholders was $673 million, versus $630 million.
Q3 operating cash flow was not separately reported; for the first nine months, operating cash flow was $249 million versus $465 million in 2014. Investing cash flow was negative $1.437 billion versus positive $1.495 billion; financing cash flow was positive $1.005 billion versus negative $1.926 billion. Cash and due from banks ended September at $470 million. The cash efficiency ratio, a non-GAAP measure, was 66.9% for Q3 and 65.7% year to date.
At September 30, total assets were $95.4 billion. Allowance for loan and lease losses was $790 million, or 1.31% of loans. Common Equity Tier 1 was 10.47%; Tier 1 and total risk-based capital ratios were 10.87% and 12.47%. Tangible common equity to tangible assets was 9.90%. The estimated fully phased-in Common Equity Tier 1 ratio was 10.37%.
Material changes versus prior periods
- Q3 continuing-operations common income and diluted EPS increased year over year, supported by higher fee income and loan growth. Taxable-equivalent net interest income rose, but the net interest margin declined 9 basis points.
- Noninterest income increased 12.7% year over year, notably from investment banking and debt placement fees, corporate services, trust and investment services, and cards and payments. The September 2014 Pacific Crest Securities acquisition contributed to comparisons.
- Noninterest expense rose 2.5% in Q3, mainly from personnel costs, including performance-based compensation and the acquisition impact. Year-to-date revenue grew 4.1% on a taxable-equivalent basis.
- Loans increased $2.7 billion from year-end 2014, chiefly commercial lending; deposits declined $925 million. Long-term debt increased $2.4 billion, including a $1 billion senior note issuance in September.
- Nonperforming loans declined to $400 million from $418 million at year-end 2014. The allowance declined from $804 million a year earlier, while Q3 provision increased to $45 million from $19 million.
Outlook, management commentary, risks and unusual items
- Management expected low-single-digit full-year 2015 net interest income growth absent higher rates, a net interest margin relatively stable with Q3, mid-single-digit noninterest income growth, relatively stable expenses, and mid-single-digit average loan growth. Management expected provision to approximate net charge-offs for the remainder of 2015, with charge-offs below its 0.40%–0.60% target range.
- Long-term goals include a 90%–100% loan-to-deposit ratio, net interest margin above 3.50%, cash efficiency ratio below 60%, and return on average assets of 1.00%–1.25%. Q3 measures were 89%, 2.87%, 66.9%, and 0.95%, respectively.
- Management described a slower Q3 economy, subdued wage and spending growth, weak inflation, and global-growth uncertainty. Interest-rate outlook and client deposit behavior remain important to net interest income and liquidity.
- Credit risks include commercial, financial and agricultural loan concentration, commercial real estate conditions, borrower defaults, and adverse economic or credit-quality changes. Commercial lending drove growth; management stated oil-and-gas exposure was about 2% of loans and credit quality remained solid.
- Key reported $14.7 billion in liquid assets and estimated its Modified Liquidity Coverage Ratio above 100%. It also reported $19.5 billion of unused Federal Reserve borrowing capacity secured by loans and $2.9 billion at the FHLB. These measures do not eliminate funding, market, or rating-related risks.
- Guarantees had maximum undiscounted potential payments of $15.38 billion and recorded liabilities of $188 million; management assessed payment/performance risk as low. Legal proceedings are ongoing; Key stated no other matter was expected to have a material adverse effect based on information then available, while noting outcomes could exceed reserves.
- Q3 pension settlement loss was $19 million; management expected an additional settlement loss related to fourth-quarter lump-sum payments. The commercial allowance methodology was enhanced in Q3, with management saying the overall allowance impact was largely neutral.
- Subsequent event: on October 30, 2015, Key announced a definitive agreement to acquire First Niagara Financial Group for 0.680 Key share plus $2.30 cash per First Niagara share, valued at approximately $4.1 billion using the cited October 29 share price. Closing was expected in Q3 2016, subject to regulatory and shareholder approvals.
Important facts for investors to verify
- Whether loan growth, fee-income momentum, and the outlook for net interest margin support earnings as deposit costs, asset yields, and interest rates change.
- Whether commercial loan credit trends, charge-offs, criticized exposures, and the allowance remain consistent with management’s credit expectations, particularly in commercial and agricultural lending and commercial real estate.
- Capital, liquidity, and funding effects of the First Niagara transaction, including approval conditions, consideration, integration plans, and expected timing.
- Whether share repurchases and dividend policy remain consistent with capital plans and regulatory requirements.
- Developments in legal proceedings, guarantee exposures, education-lending runoff and loan sales, and the assumptions used for fair-value and allowance estimates.